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Price Ceilings

ECON 130(3)

September 14-16, 2009

Sumner La Croix

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Supply, Demand, and Government Policies

In a unregulated market system with open entry and exit, market forces establish equilibrium prices and quantities.

While equilibrium conditions may be efficient, not everyone will be satisfied with the outcomes. Consumers Producers

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Price Controls...

Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.

Result in government-created price ceilings or price floors.

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Price Ceilings & Price Floors

Price Ceiling A legally established maximum price at which a

good can be sold.

Price Floor A legally established minimum price at which a

good can be sold.

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Price Ceilings

Two outcomes are possible when the government imposes a price ceiling:

The price ceiling is not binding if set above the equilibrium price.

The price ceiling is binding if set below the equilibrium price, leading to a shortage.

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A Price Ceiling That Is Not Binding

$3

Quantity ofOranges lbs

0

Price ofOranges-lb

4

Demand

Supply

Equilibriumprice

Priceceiling

100Equilibrium Quantity

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A Price Ceiling That Is Binding

$3

Quantity ofOranges-lbs

0

Price ofOranges-lb

2

Demand

Supply

Equilibriumprice

Priceceiling

Shortage

125Quantity

demanded

75Quantitysupplied

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Effects of Price Ceilings

A binding price ceiling creates…

shortages because QD > QS

Gasoline shortage of the 1970s

nonprice rationing Long lines Discrimination by sellers

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Rationing Resources Price Rationing

Efficient Impersonal

Non-price Rationing Long lines

Waste buyers time Inefficient Discrimination by sellers:

Goods may not go to buyer who value it most highly Inefficient

Potentially unfair

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Lines at the Gas PumpIn 1973, OPEC raised the price of

crude oil in world markets. Because crude oil is the major input used to make gasoline, the higher oil prices

reduced the supply of gasoline.

What was responsible for the long gas lines?

Economists blame government regulations that limited the price oil companies could charge for gasoline.

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Initially …

Price ceiling

Demand

Supply

Price ofGasoline

Quantity of Gasoline

1. The priceceilingis notbinding . . .

P1

Q1

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Then …

Price ceiling

Demand

S1

Price ofGasoline

Quantity of Gasoline

S2

2. supply falls. . .

P2

QS QD

P1

Q1

3. . . . the priceceiling becomesbinding . . .

4. . . . resultingin ashortage.

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Rent Control Rent controls are ceilings placed on the

rents that landlords may charge tenants Goal: to help the poor by making housing

more affordable New York City rent controls were enacted

as a WWII emergency measure Some units still under rent control today Many rich tenants in rich neighborhoods

paying low WWII prices.

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Rent Control in the Short Run...

Quantity ofApartments

0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Supply and demand for apartments

are relatively inelastic

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Rent Control in the Long Run...

Quantity ofApartments

0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Because the supply and demand for

apartments are more elastic...

…rent control causes a

large shortage

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Effects of Rent Control

Discrimination against any groups who are less favored by landlords.

Bribery by potential tenants. “Key” money charged??? Unbundling of services.??? Less maintenance or remodeling. Age of appliances.